Saving the Economy

Peter Peterson began his rebuttal of both Munnell’s and my comments on his analysis of social security’s problems by trotting out the old textbook definition of economics: “the science of allocating scarce resources among competing needs” [NYR, March 31]. With unemployment at 10 percent, unused capacity at 30 percent, despite unfulfilled desires, it is clear that resources are not always scarce. Economics is more than what Peterson says. It also attempts to explain and devise policy measures for a feasible growth path, despite mismatches of resources and markets and unpredictable changes in expectations.

Sustaining market growth sufficient to absorb potential output is what my discussion was about. But Peterson has read my essay wrong. I recommend not permanently accelerating federal deficits—though I think the importance of current deficits has been misinterpreted and wildly exaggerated. Private investment has been “crowded out” not by federal borrowing but by insufficient demand. To the extent that current consumption has been held up by the deficits, that has helped, not hindered, private investment. For the long term, my recommendation is that social security benefits be financed with progressive taxes. This essentially amounts to financing consumption by income redistribution. This is probably the only way to sustain rapid domestic market growth, and so investment, in an advanced industrial economy with high average standards of living.

It is ironic that Peterson criticizes me for measuring gross investment as a percent of GNP—for he himself and others have precisely urged raising investment as a proportion of GNP. My point is that it can’t be done. His rebuttal only reaffirms my point. He says we should look at the growth rate of investment, which has indeed slowed—but so has economic growth overall. So investment remains at the same proportion of GNP. I defy Peterson to suggest an answer to the dilemma I posed: if we start by saving more—as Peterson urges—sales decline, inventories pile up, and businesses cut back on investment spending. If we start with increased investment, employment and income rise, and so too does consumption. Short of wide-ranging economic planning, with investment directives and consumption controls—which Peterson would not, I think, advocate—there is no way out of this.

This is important, for it shows that attempts to raise savings are counterproductive when there is excess capacity. If a higher savings rate is intrinsically desirable—which is neither self-evident nor easily proved—saying so is not helpful if there’s no way to get from here to there. And this is a technical argument, not a bleeding-heart “utopian” and “miraculous” one, scornful phrases Peterson uses to dismiss my points without confronting them.

Rosemary Rinder

New York City

Peter G Peterson replies:

I must say that I am amazed, after our inflationary experience of the last decade, to find that Rosemary Rinder still believes the root of our current economic stagnation is inadequate aggregate demand and incomplete use of our economic resources. Let’s look at her reference to “unused capacity.” According to the Federal Reserve Board, unused capacity in US manufacturing (the broadest measure that we have) averaged 16.2 percent during the period between 1948 and 1969 and 19.7 percent during the 1970-1982 period. It is not at all clear that this change means that capital investment, once a good idea, is now an exercise in redundancy. To the contrary, I suggest that it is yet one more reflection of the declining international competitiveness of many of our basic industries; our current problem is not so much unused capacity as unusable capacity. This, in turn, can be largely attributed to insufficient new investment in plant and equipment (i.e., modernization) per worker.

Our current challenge, therefore, is not just how to ensure economic recovery, but how to ensure what General Electric’s chief executive calls a “quality recovery,” well balanced between a rise in consumer spending, a resurgence in exports, and a desperately needed renaissance in new investment.

I frankly do not see how this balance can occur so long as long-term real interest rates remain at their present heights—levels unprecedented during a period of weak demand. High interest rates are clearly choking off current plans for investment by denying them any chance of finding affordable financing. Moreover, by driving up the exchange-rate value of the dollar, high interest rates have crushed our export industries. Over a third of the decline in real GNP in the most recent recession was in net exports. One of the quickest ways we could bring down the 10 percent unemployment rate cited by Rinder would be to restore the estimated one to two million export-related jobs that we have lost over the past couple of years. Yet I do not see how these long-term interest rates can possibly decline much so long as lenders and borrowers look forward to ever-larger federal deficits. According to current projections, federal deficits of 5 percent to 6 percent of the GNP by the mid-1980s threaten to absorb more than half of net savings of the private sector.

Ironically, our dolorous economic performance during the 1970s coincides with just the sort of “policy measures” that Rinder recommends. Let’s turn to the trend in national savings and investment as a percent of GNP, measured not in “gross” terms (as Rinder suggests) but in “net” terms (to correct, as we should, for the depreciation of “wear and tear” on our aging capital stock). During the earlier period (1948-1969), our net national savings rate as a percent of GNP averaged 7.4 percent; during the later period (1970-1982), it averaged 5.7 percent. Does Rinder seriously argue that our capacity and unemployment (to say nothing of productivity) measures will improve if we push that rate still lower? Perhaps she ought to start by convincing Japan, whose net savings rate is about three times higher than our own, that its policy measures have been one gigantic mistake.

Rinder implies that it is impossible ever to raise the rate of savings and investment. The historical and international evidence suggests no such thing. If it did, we would still be living in a preindustrial world.

There are two basic problems with Rinder’s method of analysis. The first problem is that it is terminally nearsighted. She is correct only in a highly specific and limited sense: if you want to guarantee an increase in aggregate demand over the next few months, a good way to do it is to borrow from those (e.g., potential investors) whose immediate spending plans are contingent and give to those (e.g., potential consumers) whose immediate spending plans are certain. In a longer-run framework, however, it should be obvious that investment spending is just as effective in sustaining aggregate demand as consumer spending.

The second problem is that Rinder’s deficit prescription, when it causes interest rates to soar or in this case to remain high, no longer makes sense even as a near-term cure.

Given the acutely depressing consequences of currently high real interest rates—not only on investment goods, but on exports and on consumer durables such as autos—the “near-term” could hardly be worse. It is likely that a long-term assurance of smaller federal deficits would, by bringing long-term interest rates down, achieve a higher net savings rate without any near-term stagnation of demand. It is clear that a critical deficiency of Rinder’s thoroughly “Keynesian” method of analysis is that it nowhere explains how you can have lofty real interest rates in the midst of a recession. Perhaps this is understandable. Keynes did not encounter an economy throttled, as ours is today, by the combined prospect of permanently low private-sector savings and structurally high public-sector borrowing. If he had, I doubt that he would have proposed the same solution as he suggested for an economy that was suffering from underspending in both the public and private sectors.